Departments Emner "Monetary policy"

The problem of parity in Kumhof and Noone's design principles for Central Bank Digital Currencies

Bjerg, Ole(Frederiksberg, 2018)

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This paper is a critical engagement with the four design principles for Central Bank
Digital Currency (CBDC) recently proposed by Kumhof and Noone (KN). It is argued
that the implicit notion of parity underlying KN's analysis is too narrow as it is only
focused on the exchange rate between CBDC and bank deposits. Instead, we develop a
three dimensional model of parity, which also includes the concepts of purchasing
power parity and settlement parity. Applying this model to KN's proposal, the paper
identifes four potential breaking points, where their principles provide a weaker defense
of parity between CBDC and bank deposits than what is suggested by their analysis:
Gilt traders may create a break of purchasing power parity as they respond to a crisis
by quoting different gilt prices depending on whether payment is made in CBDC or
bank deposits. Speculators may provoke a break of either purchasing power parity or
exchange rate parity by buying gilts for bank deposits, thus forcing the central bank to
buy gilts for CBDC, and then subsequently selling gilts for CBDC. The Treasury may
find itself forced to break settlement parity, if citizens create a 'run' by using only bank
deposits to make payments to the government, while demanding payments from the
government in CBDC. And finally the central bank cannot use the interest rate on reserves
as a separate policy tool to guide the risk-free interest rate in the economy as reserves
carry the risk of a break of settlement parity in relation to CBDC.

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The prospect of central banks issuing digital currency (CBDC) immediately raises the question of how this new form of money should co-exist and interact with existing forms of money. This paper evaluates three different scenarios for the implementation of CBDC in terms of their monetary policy implications. In the ‘money user scenario’ CBDC co-exists with both cash and commercial bank deposits. In the ‘money manager scenario’ cash is abolished and CBDC co-exists only with commercial bank deposits. And in the ‘money maker scenario’ commercial bank deposits are abolished and CBDC co-exist only with cash. The evaluation is based on an adaption of the classical international monetary policy trilemma to a domestic monetary system with multiple forms of money. Our proposition is that a monetary system with two competing money creators, the central bank and the commercial banking sector, can simultaneously only pursue two out of the following three policy objectives: Free convertibility between CBDC and bank money, parity between CBDC and bank money, and central bank monetary sovereignty, which is the use of monetary policy for anything else than support for commercial bank credit creation. This means that the decision on the design of a monetary system with CBDC implies a crucial political decision on the priorities of the central bank.

Despite expansive monetary policy with negative interest rates and Quantitative Easing (QE), the European economy is stuck in a situation with deflationary pressure and low growth. A neglected explanation for the ineffectiveness of monetary policy is the fact that technological development and deregulation of the banking sector have turned bank deposits into the most important means of payment in the economy, whereby private banks now account for the largest share of money creation in society – making private banks' credit policy the catalyst of monetary policy rather than vice versa. This development seriously questions mainstream theories on monetary policy and sets the stage for adopting a new theoretical framework for understanding the dynamics of the monetary system and the execution of monetary policy. The situation has also got practical implications: In order to restore central banks’ capacity to create the most liquid and convenient form of money in the economy – and regain public control over monetary policy – Central Banks should consider introducing Central Bank Digital Currencies (CBDC) with universal access for the whole economy.

This paper is a review of Danmarks Nationalbank's recent analysis of the prospects
of implementing a Central Bank Digital Currency (CBDC) in Denmark.
We concur with Nationalbanken's conclusion that CBDC does not add efficiency
or further functionality to existing payment solutions. We argue, however, that
their analysis fails to take into account the potentials for increased financial stability
given the fact that CBDC carries no credit risk. We also find that Nationalbanken's
dismissal of CBDC on the grounds that it does not provide new
monetary policy tools, since interest rates are bound by the fixed exchange rate
regime, fails to consider the value of CBDC in the event of a future crisis. Finally,
we argue that the Nationalbanken's views may reflect a primary concern with
the preservation of the existing banking sector in its current form over and above
the needs of the general public.